When a seller and a buyer, i.e. trading participants, agree to a particular price for a financial instrument they complete a trade (i.e. complete a verbal, or electronic, transaction involving one party buying a financial instrument from another party). The trades are initiated and completed by the trading participants; such as individuals, firms, dealers (who may be either individuals or firms), traders and brokers. Trading of financial instruments is generally performed on an exchange, i.e. a trading venue and the trading is typically done through brokers, or traders, who buy or sell the financial instruments on behalf of investors. The term “financial instruments” is used herein in a broad sense and encompasses any tradable item i.e. securities, derivative or commodity, such as stocks, bonds, cash, swaps, futures, foreign exchange, options, gas electricity and so forth, or group of items that is traded through matching of counterparty orders (bid, offer).
There are a lot of various types of exchanges (i.e. marketplaces in which financial instruments are traded) for different financial instruments. Examples of such exchanges are ‘open out-cry’ exchanges, such as the New York Stock Exchange and automated electronic exchanges, such as the NASDAQ Stock exchange.
A conventional automated exchange typically receives order input data, in the form of data messages, from external devices used by the traders, or the brokers. The traders, or brokers, submit orders and/or quotes (or alterations/cancellations thereof) to the automated exchange for purposes of trading.
In this context, an order is a request to sell or buy a financial instrument from any trading participant of the automated exchange and a “quote” may be an “offer” price, a “bid” price, or a combination of both an “offer” and “bid” price of a financial instrument, and is determined from quotations made by market makers (or dealers). In this context, a market maker is defined as a company, or an individual, that quotes both a buy and a sell price in a financial instrument, or commodity held in inventory, hoping to make a profit on the bid-offer spread. Typically the market maker is a trading firm, registered with the exchange operator, to trade a predetermined amount of a desired financial instrument.
The orders/quotes may relate to buying and/or selling of any type of financial instrument. In particular, the input data to the automated exchange can be an order data message that represents the placing of a new bid or sell order, or a new quote. The order data message can also represent the change of an existing bid or sell order, or a quote. In addition, the order data message can represent a cancellation/change of an existing bid or sell order, or a quote.
Further, in trading of financial instruments, different types of market models are defined. Two well known market models are ‘Order driven’ markets and ‘Quote driven’ markets. The difference between the two market models is what type of orders/quotes that are accepted by the exchange and also what is displayed in the market, in terms of orders and bid and ask prices.
The order driven market displays all of the bids and asks, while the quote driven market focuses only on displaying the bids and asks that are submitted by the market makers; i.e. the quotes. Also, in a quote driven market, one side of a matched trade typically includes a quote by a market maker. As a result, orders are typically not allowed to rest, i.e. be stored, in an order book in a quote driven market. On the other hand, in an order driven market, all of the orders of both buyers and sellers are displayed, detailing the price at which the buyers and sellers are willing to buy, or sell, a financial instrument and also the amount of the financial instrument that the buyers and sellers are willing to buy or sell at that price. Thus, in an order driven market, all orders are continuously matched and all types of orders can be entered, but no quotes can be entered. Further, in the order driven market, the price dissemination is sent, or broadcasted, based on the traded orders and the orders resting, i.e. being stored, in the order book.
An advantage provided by the order driven market is that it is transparent in that the order driven market shows all of the orders and at what prices trading participants are willing to buy or sell.
A drawback is that, in the order driven market, there is no guarantee of order execution. However, in the quote driven market, there is an order execution guarantee present, provided that the buy and sell prices match.
In the quote driven market, even though individual orders are not seen, the market maker will either fill an entered order from its own inventory, or match the order with another order. Thus, in the quote driven market, all orders are continuously matched with a quote. All quotes can be entered and allowed to rest, i.e. being stored, in the order book, but only orders that can be matched instantly may be entered. That is, no orders can rest in the order book. Further, in the quote driven market, the price dissemination is sent, or broadcasted, based on the quotes in the order book.
A major advantage of the quote driven market is the liquidity it presents. This, as the market makers are required to meet their quoted prices, either buying or selling. A major drawback of the quote driven market is that, unlike the order driven market, it does not show the transparency in the market (i.e. individual orders are not visible in this market model).
Further, there are markets that combine attributes from the two systems, to form so called hybrid markets. For example, a hybrid market may show the current bid and ask prices of the market makers, but also allow orders to stay in the order book and allow trading participants to view all of the orders stored in the orderbook.
FIG. 1 illustrates a conventional automated exchange system 100 comprising trader terminals 101 that are used for issuing order data messages, i.e. input data received by the automated exchange 104. The trader terminals 101 are connectable, for example over the internet 102A, or over some other connection means like a dedicated fiber 102B, to an electronic marketplace, i.e. an automated exchange 104. The automated exchange 104 can be hosted on a computer server. Sometimes the trader terminals 101 are connected to the automated exchange 104 through an entry gateway 103 connected to or being a part of the automated exchange 104 and configured to receive market actions from the trader terminals 101. An entry gateway 103 is usually in connection with the automated exchange 104 on a dedicated network and forwards the market actions to the automated exchange 104 and further usually broadcast updates, back to the trader terminals 101. It should be understood that information being communicated to and from the automated exchange 104 and the trader terminals 101 could be communicated via a single communication path.
While the trading terminals 101 in FIG. 1 are illustrated as trading terminals that traditionally are associated with manual input of market actions, the trading terminals 101 can also be implemented as an algorithmic trading unit, sometimes termed automatic order generator, with manual input means for control of the algorithmic trading unit. The algorithmic trading unit is pre-programmed with instructions to automatically generate sell and buy orders and quotes (or changes/cancellations thereof) in response to input data received from the automated exchange 104. The trading terminals 101 also represent market makers inputting quotes to the automated exchange 104.
The trader terminals 101 also receive data back from the automated exchange 104. Typically, the received data is market data such as prices and volumes in different financial instruments, produced by the automated exchange 104 or received from some other source of information. The market data contains information that characterizes the various tradable financial instruments, including among other parameters, order related parameters, such as price and quantity and the inside market, which represents the lowest sell price (also referred to as the best or lowest ask price) and the highest buy price (also referred to as the best or highest bid price). In some electronic markets, the market data may also include market depth (or a part thereof), which generally refers to quantities available for trading the tradable financial instruments at certain buy price levels and quantities available for trading the tradable financial instrument at certain sell price levels.
Conventional automated exchange systems 100, as described above, are designed to operate in accordance with some predefined market model. Depending on which market model the automated exchange system 100 is designed to operate in accordance with, the automated exchange system 100 will be associated with the advantages and the drawbacks associated with that specific market model. There is, due to today's frenetic markets, a constant need and desire to improve upon existing automated exchange systems 100 and to provide solutions that operate with fewer drawbacks than pre-existing automated exchange systems 100. Hence, there is a need for an improved automated exchange 104.